When market participants talk about the office market, it is interesting to hear all of the divergent views on where the market is headed. These conversations often revert to topics like job growth, space utilization trends and the increasing number of folks who are working from home.
In the broader investment sales market in New York City, underlying fundamentals are improving but not nearly to the extent that they justify the tremendous increases in property values that we have seen. The office building market is no different.
Taking an average of the various reports the major firms publish, the average vacancy rate in Midtown decreased from 8.1 percent in 2012 to 8.0 percent in 2013. In the Downtown Manhattan market, the vacancy rate was up from 8.0 percent to 10.9 percent over the same period, and in Midtown South, the tightest market in the city, the vacancy rate increased from 5.7 percent to 7.2 percent. While the market seems to be getting better, these numbers appear counterintuitive. But it is because of the amount of new space delivered to the market that these numbers make sense. In Midtown, Midtown South and Downtown combined, 5.5 million square feet of office space was completed last year, compared to 68,000 square feet in 2012 and 135,000 square feet in 2011.
At the same time, average rents in these markets have risen. In Midtown, the average rent last year rose to $58.47 per square foot from $55.75 in 2012, a 4.9 percent increase. Downtown, rents jumped 5.5 percent from $39.74 per square foot in 2012 to $41.92 in 2013. And remarkably, in Midtown South, rents rose from $49.47 per square foot in 2012 to $54.17 last year, a 9.5 percent increase.
While these increases in rents are impressive, they do not nearly justify the increases in property values that we have observed in the office sector. At the peak of the last cycle in 2007, office properties in Manhattan averaged $822 per square foot. This average dropped to $528 in 2010, a 35.8 percent drop. In 2013, this average rose to $952 per square foot, an all-time record. This represented a 20.5 percent increase over 2012 and a whopping 80.4 percent increase since the trough of the market in 2010.
These increases in value are more indicative of cap rate compression than rent increases. The average office building cap rate in Manhattan in 2009 was 6.9 percent (it is hard to believe it could have been so high such a short time ago). In 2013, cap rates dropped to 4.6 percent, indicating a growing trend of investors bidding up prices to the point where yields have become extraordinarily low.
The volume of sales in Manhattan’s office sector in 2013 followed a trend seen in other property sectors. The dollar volume of sales increased significantly, while the number of properties sold fell. These metrics demonstrated a huge increase in the average price paid for an office building in Manhattan.
In 2009, the dollar volume in the office sector was just $1.97 billion. This figure rose to $10.5 billion in 2012. Last year, the total dollar volume in the Manhattan submarket was $14.8 billion, a 41.0 percent annual increase. However, the number of office buildings sold last year dropped by 32.7 percent to 74, down from the 110 properties that traded hands in 2012. These divergent metrics from 2012 and 2013 resulted in a massive increase in the average price of an office property sold. In 2012, the average office building’s sales price was $95.4 million. This figure exploded to $200 million last year, a whopping 109.6 percent increase.
The massive increase in the average price of a property sold, while a smaller number of properties were sold, is the result of a resurgence of the mega-deal in 2013. In 2012, the largest transaction in the city was the $750 million sale of the King’s Plaza retail mall in Brooklyn. Last year, there were four office transactions in Manhattan of more than $1 billion. These sales included the GM Building, 30 Rockefeller Plaza and 650 Madison.
In 2012, there were 43 office sales in excess of $100 million and 56 that were more than $50 million. Last year, these figures fell to 29 and 37, respectively. Of those, however, 10 sales were closed with a price of $500 million or higher in 2013, as opposed to only one in 2012.
The resurgence of office building sales activity in 2013, while anticipated, was a positive shot in the arm for the market. Given what we have seen thus far in 2014, we expect these positive trends to continue well into the year.
Robert Knakal is the chairman and co-founding partner of Massey Knakal Realty Services. He has brokered the sale of approximately 1,500 properties, with a market value in excess of $10 billion.